Dividend shares are the unsung heroes of investing. News reports follow the daily ups and downs of indexes like the FTSE 100, giving the false impression that investors only make money when stocks rise.
Yet stocks listed on the FTSE 100 pay some of the most generous dividends in the world. The average yield is 3.91% but it’s easy to find companies yielding 7%, 8% or even 9% a year. That’s a terrific rate of income, especially as savings rates peak and fall.
Currently, I reinvest all the shareholder payouts I receive straight back into my portfolio. That way they buy more shares, which pay more dividends, which buy more shares, in a constant virtuous circle.
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High and rising income
Even a relatively small sum such as £5,000 can build up into something quite impressive. It won’t happen overnight, though. Generating income of £5k from a £5k lump sum is the work of decades. But that’s what investing is all about. It’s a get-rich-slow strategy, not a get-rich-quick one. So it pays to start early.
I’d start by setting up a Stocks and Shares ISA, which would allow me to take all my capital gains and dividend income free of tax. Once that’s done, buying shares is easy and cheap, with trading costs of as little as £5 a pop, depending on the account, plus 0.5% stamp duty.
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Then I’d start researching shares that I believe would pay me a sustainable, rising income over time. Here’s a couple of examples from my own portfolio. Lloyds Banking Group is forecast to deliver income of 6.4% in 2023, handsomely covered 2.8 times by earnings, while insurer Legal & General Group yields 8.48%.
There are loads more great income stocks out there. For those happy to invest in cigarette stocks, British American Tobacco yields a thumping 8.66%. I wouldn’t expect much share price growth, though, as smoking declines over time.
Patience is a virtue
These three stocks would give me an average yield of 7.85%. Which isn’t half bad. If I reinvested every penny, my initial £5k would have more than doubled to £10,646 after 10 years. That’s in the unlikely circumstance that their share prices didn’t rise at all.
After 20 years, I’d have £22,666 and £48,259 after 30 years. That would give me a passive dividend income of £3,788 a year.
Now, let’s assume these stocks did grow, at a modest average rate of 2.5% a year. That would lift my total average return to 10.35% a year. After 30 years that would turn my £5k into £95,971. If my shares were still yielding 7.85% a year that would give me income of £7,544.
Obviously, these figures are simplistic. Yields aren’t guaranteed, and can be cut if profits or cash flows decline. Share prices can fall as well as rise, shrinking my capital. Companies can go out of business.
Buying individual stocks will always be risky. People do it because the potential rewards are higher, too. Turning a £5k a lump sum into income of £7.5k a year sounds like magic but can be done. It takes time, though.
